- United States
Harley-Davidson, Inc. (NYSE:HOG) Shares Could Be 24% Below Their Intrinsic Value Estimate
- Using the 2 Stage Free Cash Flow to Equity, Harley-Davidson fair value estimate is US$49.17
- Harley-Davidson's US$37.26 share price signals that it might be 24% undervalued
- The US$51.65 analyst price target for HOG is 5.1% more than our estimate of fair value
Does the March share price for Harley-Davidson, Inc. (NYSE:HOG) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for Harley-Davidson
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$640.0m||US$859.5m||US$893.3m||US$923.4m||US$950.9m||US$976.7m||US$1.00b||US$1.03b||US$1.05b||US$1.07b|
|Growth Rate Estimate Source||Analyst x1||Analyst x2||Est @ 3.93%||Est @ 3.37%||Est @ 2.98%||Est @ 2.71%||Est @ 2.52%||Est @ 2.38%||Est @ 2.29%||Est @ 2.22%|
|Present Value ($, Millions) Discounted @ 14%||US$562||US$662||US$604||US$548||US$495||US$446||US$401||US$361||US$324||US$290|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.7b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 14%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$1.1b× (1 + 2.1%) ÷ (14%– 2.1%) = US$9.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$9.2b÷ ( 1 + 14%)10= US$2.5b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$7.2b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$37.3, the company appears a touch undervalued at a 24% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Harley-Davidson as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 14%, which is based on a levered beta of 2.000. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Harley-Davidson
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividends are covered by earnings and cash flows.
- Dividend is low compared to the top 25% of dividend payers in the Auto market.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Annual earnings are forecast to grow slower than the American market.
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Harley-Davidson, we've put together three pertinent factors you should look at:
- Risks: Every company has them, and we've spotted 3 warning signs for Harley-Davidson (of which 1 can't be ignored!) you should know about.
- Future Earnings: How does HOG's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
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Find out whether Harley-Davidson is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Harley-Davidson, Inc. manufactures and sells motorcycles in the United States and internationally.
Undervalued with solid track record and pays a dividend.